Event update: Zee Entertainment (Outperformer) - Annual Report Analysis – Investing (in content) for the future

Zee Entertainment’s (Z) FY18 annual report reiterates Z’s strength as a ‘multi-faceted global entertainment content company’. Z has become India’s largest non-sports entertainment network in FY18 in terms of viewership market share. The company will continue with its strategy of ‘expanding the regional portfolio by entering new markets and adding products in existing ones’. Investments in ZEE5, its digital video OTT platform, continue unabated as Z is hopeful of populating it with 90 original shows across six languages by FY19E end. As content investments remained high (across domestic broadcasting, international, digital, music and live), FY18 saw 49% fall in FCF to Rs2.4bn, lower-than-expected on significantly higher incremental working capital requirements (largely for satellite rights of movies) and higher tax rate. Contingent liabilities fell 40% to Rs7.0bn on sale of sports business, while investments in unquoted mutual funds (Poseidon & Actinium) increased 25.6% to Rs5.4bn, even as Rs3bn was redeemed from SICOM. We maintain our Outperformer rating on the stock with a target price of Rs654.

FCF falls 49% yoy in FY18 on higher working capital (WC) investments: Z’s 49% yoy fall in FCF to Rs2.4bn was below our expectation on high inventory (increased 55% to Rs26.3bn) owing to aggression in acquisition of satellite rights of movies, as Z plans to launch Malayalam market and movie channels across Karnataka/Tamil Nadu. Of the total inventory, 60% is expected to be recovered after 12 months (versus 64% yoy), highlighting Z's solid ramp-up in future content slate. We expect content investments to remain elevated in the near-term.

Current investment profile improves marginally but more needs to be done: In FY18, Z redeemed Rs3bn worth of investment in SICOM, which was a welcome move. However, the company increased its investment in SGGD Projects to Rs1.7bn (vs Rs1.5bn yoy), which is outstanding and overdue; Z has initiated legal action by enforcing the security attached to the said debenture and hence considers it good. Investments in unquoted mutual funds (Poseidon & Actinium) rose 25.6% to Rs5.4bn.  

26.5% earnings CAGR over FY18-20E: We expect 18.3% EBITDA CAGR over FY18-20E, led by 17.5% CAGR in both ad revenue (with some help from digital) and domestic subscriber revenue. Given Z’s cost-efficient business model, we expect 15.5% CAGR in expenses, even as it invests more in TV, film and digital and this should lead to strong 26.5% LTL earnings CAGR over FY18-20E. We expect FCF generation to improve from the depressed levels of FY18 and expect Rs8.7bn of FCF in FY20E; this should allay investor concerns over Z’s poor FCF generation. We maintain our Outperformer rating.